G7 seeks to defuse currency war fears

The Group of Seven leading industrial nations, which includes the U.S., Japan and Germany, warned Tuesday that volatile movements in exchange rates could adversely hit the global economy.

There have been increasing concerns around the world that countries might manipulate their exchange rates through their domestic economic policies in order to gain an edge. A lower foreign exchange rate can make a country's exports cheaper, thereby boosting growth. But one currency can fall only if another rises - which in turn will create trade problems for other countries.

This process could spark a "currency war" — a destabilizing battle where countries compete against one another to get the lowest exchange rate.

In a statement published Tuesday on the Bank of England website, the G-7 finance ministers and central bankers insisted they remained committed to exchange rates driven by the market — not government or central bank policies — and would consult closely when it comes to sharp movements in foreign currency markets.

"We are agreed that excessive volatility and disorderly movements in exchange rates can have adverse implications for economic and financial stability," said the G-7, which also counts Canada, France, Italy and current president, the U.K., among its members.

The statement comes ahead of a meeting in Moscow at the weekend of finance ministers from the world's top 20 industrial and developing countries. In light of the recent swings in the foreign exchange markets, notably relating to the Japanese yen, currency issues were expected to feature heavily during the Group of 20 discussions in the Russian capital.

Central banks, which are set up to operate independently of any government, play a key role in the value of a currency. By setting interest rates and the supply of money in an economy, they in turn influence how valuable a currency is.

Much of the recent volatility in foreign exchange markets has been a by-product of developments affecting the Japanese yen, which dropped Tuesday to its lowest level against the dollar since May 2010. Though the Japanese government has not directly intervened to get the value of the yen down, it has set in motion a series of economic policies, such as setting a higher 2 percent inflation target for its central bank that many in the markets think will lead to more money being created.

The falling yen has contributed to the rising value of the euro. That could have a negative impact on the economy of the 17 European Union countries that use the single currency, which is already in recession. It could be bad for automakers, aircraft manufacturers and other businesses that depend on exports for growth.

Though Japan insists it's not targeting any particular exchange rate, there are fears that the benefits the country will potentially enjoy from the lower yen may force others to start using their currencies as an economic weapon.

That's where the problems really start and conjures up images of the 1930 when countries pursued tit-for-tat devaluations in order to get an edge. However, the outcome was to decimate global trade, accentuate the depression and sow the seeds for World War II.

Several European leaders have highlighted the increase in the value of the euro as a potential problem, with French President Francois Hollande going as far to say the Eurozone should target an exchange rate for its currency.

However, European Central Bank President Mario Draghi dismissed politicians' comments that the ECB should influence the exchange rate of the euro.

"They are fruitless and frankly increase the confusion around exchange rates and frankly we don't need that," Draghi said at a news briefing Tuesday after speaking with members of the Spanish parliament.

Olli Rehn, the European Commission's top monetary affairs official, said a stable currency system was in everyone's best interest.

"Excess volatility and disorderly movements in exchange rates can have adverse implications for economic and financial stability," said Rehn at the conclusion of a meeting of the EU's 27 finance ministers in Brussels. "And that's why we need to lean on active international policy coordination in order to prevent a wave of competitive devaluations."

The G-7 did not voice any direct concerns over the new Japanese economic approach, which the government hopes will get the world's number 3 economy growing again following two decades of stagnation and deflation. After all, Japan was a signatory of the statement.

"We reaffirm that our fiscal and monetary policies have been and will remain oriented towards meeting our respective domestic objectives using domestic instruments, and that we will not target exchange rates," the G-7 said.

Kiran Kowshik, a foreign exchange strategist at BNP Paribas, said the G-7 statement is unlikely to stop concerns about the recent developments in currency markets from being aired, and that the G-7 effectively gave traders the "green light" to carry on selling the yen.

In the immediate aftermath of the G-7 statement, the yen was sold off but then rallied strongly on speculation that an unnamed G-7 official later said the statement had been misinterpreted.

The euro was up 0.2 percent at $1.3420 while the dollar lost early gains against the Japanese yen to trade 0.4 percent lower at 93.85 yen. The yen was extremely volatile Tuesday — the dollar earlier hit a 21-month high of 94.40 yen, before falling sharply to 93.28 yen.

Kowshik added that the G-7 has "historically tended to back Japan in its policies" and that the statement laid the ground for what could be a "tense affair" in Moscow.

"There are a number of other countries like China, Russia, South Korea, etc. who have an increasing importance in the G-20 and are probably not too happy with some of the recent Japanese rhetoric," he said.

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Don Melvin in Brussels and David McHugh in Frankfurt contributed to this story.